updated 10/24/2007 4:57:36 PM ET 2007-10-24T20:57:36

Merrill Lynch & Co. on Wednesday took a $7.9 billion writedown because of the summer's credit crisis, a bigger-than-expected amount that raised the specter of more trouble ahead from risky home loans.

The world's largest brokerage was caught off guard by its bad bets, leading to its first loss in six years. Merrill Lynch's quarterly performance was the worst by far of the Wall Street firms.

The shortfall calls into question how one of the biggest names in finance could be so off the mark, just three weeks after telling Wall Street its losses would be significantly less.

"I'm not going to talk around the fact that there were some mistakes that were made," Chairman and Chief Executive Stan O'Neal told analysts during a conference call. "The market environment has showed renewed signs of volatility and weakness, as shown by recent downgrades on thousands of mortgage securities by rating agencies."

Last week Standard & Poor's downgraded more than $45 billion worth of securities backed by risky mortgages — some of which were made as recently as the first half of this year — creating renewed concerns about weakness in the market.

O'Neal said the company continues to face uncertainty as global investors shy away from risky investments, especially in the once booming fixed-income markets where mortgages are packaged together and sold as securities. The value of these investments has been difficult to determine — one reason Merrill Lynch said its third-quarter results were sharply worse than it initially expected.

The broker reported a loss after paying preferred dividends of $2.31 billion, or $2.82 per share, compared to a profit of $3 billion, or $3.50 per share, a year earlier. Revenue, after factoring in some of its losses, fell 94 percent to $577 million from $9.83 billion a year earlier.

Results missed Wall Street expectations for a loss of 45 cents per share on $3.25 billion of revenue, according to analysts polled by Thomson Financial.

For a number of analysts, the loss shined a harsh light on the company's risk management process.

"Results reflected what we see as poor risk management in U.S. fixed income and higher charges than announced only 2 1/2 weeks ago," said Deutsche Bank analyst Michael Mayo in a research note. "The lingering question in our minds is whether all of the write-downs have been taken."

Other analysts were equally as critical, with Standard & Poor's Ratings Services downgrading the company on a writedown it labeled "staggering." While Merrill's ratings are far from junk status, any drop makes it more expensive to borrow money — a potentially crippling event for any investment bank.

Merrill, like many of its rivals, was battered as concerns about mortgage securities triggered a global aversion to risk. Weak credit markets also forced it to write down the value of leveraged buyout loans — about $463 million — as investors refused to finance them. Such loans were a Wall Street staple during the merger and acquisition boom.

But the biggest trouble spot for Merrill was its fixed-income business, which is typically one of the company's top earnings drivers. Revenue in the unit was actually negative, some $5.6 billion in total, because of its CDO and subprime mortgage exposure.

A majority of the losses came from marking down the value of complex financial instruments known as collateralized debt obligations, or CDOs, and from declines in subprime mortgages — loans to customers with shaky credit.

Shares in Merrill fell $3.90, or 5.8 percent, to close at $63.22 Tuesday. Fox-Pitt, Kelton analyst David Trone, in a note to clients, said any sell-off in the shares would be on "an array of credibility issues," including questions about how the company could lose so much money and get its initial pre-announcement so wrong.

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